Midterm 1ECO 321Fall 2016Prof. CabralInstructions: There are 5 questions in total, each with several parts. Write your answersin a bluebook to be handed in at the end of the test. Only calculators with no 3G or wifitechnology are permitted to be used on this test. Good luck!1. [20 pts] Suppose that there are exactly two fishermen, Zach and Jacob, that fish off of the nearby coast. They each benefit from the construction lighthouses. The marginal cost of building each additional lighthouse is 100. The marginal benefit to Zach of each additional lighthouse is 90-2Q, and the marginal benefit to Jacob is 40-Q. Q is the number of lighthouses.a. [4 pts] Explain in words why we might not expect to find the efficient number of lighthouses along this coast. (3 sentences maximum).When Zach makes his private decision he does not taken into account the benefits that would accrue to Jacob (and vice versa). We would expect that ifthey acted independently, they would under-invest in lighthouses and there would be fewer than efficient lighthouses on the coast.b. [8 pts] What number of lighthouses would be provided if Zach and Jacob decided independently on their lighthouse expenditures?Zach: PMBz=90-2Q<100=PMC=SMC for all Q, this implies that he will chose zero lighthousesJacob: PMBj=40-Q<100=PMC=SMC for all Q, this implies that he will chose zero lighthouses The total provision of lighthouses is zero.c. [8 pts] What is the efficient number of lighthouses? SMB=PMBz+PMBj=130-3Q=100=SMCSolving for Q we get the efficient number of lighthouses is 10.2. [24 pts] Suppose the government is considering a highway improvement project. According to the engineers’ estimates, the necessary inputs/costs and benefits are expected from the projects. You are hired to do a cost benefit analysis.QuantityCosts (incurred only in current year) Asphalt 1 million bagsLabor 1 million hoursBenefits (incurred in each year including current year)Driving timesaved400,000hours/yearLives Saved 1 life/yearYou are told that the government’s discount rate is 6%. Suppose you are informed that asphalt costs $10 per bag, and that asphalt is sold in a perfectly competitive market. Suppose that workers are hired for the projects at the prevailing wage rate in the privatemarket, $25, and ¾ of the worker-hours are provided by individuals would have been employed otherwise. Unemployed workers value their time at $10 per hour.a. [6 pts] What is the present discounted value of the costs of this project (using the opportunity cost approach)?Costs=10*1mill+0.75*1mill*25+0.25*1mill*10=31.25 millionYou find a study that documents wait times and gas prices at retail gas stations in the 1970s. Gas station A offered gas for $0.50 less per gallon than gas station B, and the lines were 20 minutes longer at gas station A than at gas station B. The mean amount of gallons purchased were 10. b. [6 pts] How would you value one hour of driving time saved based on this evidence?Approximately $15.(People spend extra 20 minutes to save $5.)c. [2 pts] What is one limitation of the estimate you provided in part b? Many possible answers. Some include: -The estimate is relevant for the marginal individuals just indifferent between the two gas stations. It could be the value of time for inframarginal individuals is much different.-Number is from the 1970s.d. [8 pts] Suppose that the government values individual’s lives at $8 million per life. Based on this and your estimate from part b, what is the present discounted value of the benefits of the project over the first 3 years of the project?Yearly stream of benefits: 1*8mill+ 15*0.4mill=14 millionBenefits over 5 years PDV=14*[1+(1/1.06)+(1/1.06)^2]=14mill * 2.83=39.67 millione. [2 pts] If the government’s time horizon is 3 years, should the government do this project? The govt should do this project if the time horizon is 3 years because the PDV of benefits exceeds the costs.3. [18.5 pts] A researcher is trying to investigate the impact of a smoking ban. The state of Economica implemented a smoking ban in all restaurants in 1990. Meanwhile, the neighboring state of Mathematica continues to allow smoking in restaurants (it has always allowed it). The following table displays the rate of respiratory-related illness among restaurant workers in Economica and Mathematica over time. Rate of respiratory illnessBefore 1990 After 1990Economica 150 per 1,000 workers 50 per 1,000 workersMathematica 175 per 1,000 workers 125 per 1,000 workersa. [6 pts] Using a before-after strategy, estimate the effect of the smoking ban on the rate of respiratory illness among restaurant workers. The rate declined by 100 cases per 1000 workers.b. [8 pts] Using a difference-in-difference strategy, estimate the effect of the smoking ban on the rate of respiratory illness among restaurant workers.The rate declined by 50 cases per 1000 workers.Since the 1980s, the overall population rate of smoking has declined sharply. Suppose that Economica and Mathematica experienced similar declines in the population smoking rate.c. [4.5 pts] Which of these estimates provides an unbiased estimate of the smoking ban? Explain your answer in no more than 3 sentences.The difference in difference strategy nets out the time trend in population smoking rates common across Economica and Mathematica. Therefore, the difference in difference estimate is unbiased while the before-after estimate is biased.4. [22.5 pts; 2.5 pts each] True/False. Write out “True” or “False” (do not abbreviate with T and F). a. Education is a pure public good.False.b. In a cost benefit analysis framework, hiring people who would otherwise be unemployed is considered to be a benefit and not a cost.False.c. Cable television is an example of an impure public good because it is rival and non-excludable.False.d. In an unregulated market, a good will be overproduced when the good is associated with a positive production externality.False.e. Public provision of a good is less likely to crowd out private provision whenthe individuals behave as in the “warm glow model”.True.f. The Coase theorem tells us that assigning property rights can overcome anegative externality only if all the property rights are assigned to the party who suffers from the externality.False.g. The relevant interest rate in present value calculations in cost benefit analysis is higher when evaluating a public project than when evaluating aprivate project.True.h. Suppose each